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We recently concluded a five-part series on the likely impact of the US-Kenya Free Trade Agreement on various industries.
Negotiations to conclude the US-Kenya FTA have since slowed down. While the US Trade Representative and Kenya Cabinet Secretary for Industrialisation, Trade and Enterprise recently met to discuss bilateral relations, no commitments were made with respect to the FTA. In the meantime, the Economic Partnership Agreement (EPA) between Kenya and the UK has become operational. Given that Kenya has concluded one bilateral agreement and is pursuing a second, this two-part series considers the practical interplay between these agreements and Kenya’s commitments to the East African Community (EAC).
In this first part, we discuss the interaction between the tariff regimes of the EAC Customs Union and the Kenya-UK EPA, including the possible divergence in tariff treatment of similar products under the two trade agreements.
To explain the operation of the Kenya-UK EPA vis-à-vis the EAC Customs Union, it is prudent to understand the various concepts at play. Both the EPAs and customs unions fall within the scope of Regional Trade Agreements (RTAs), but EPAs more closely resemble FTAs. RTAs serve as exceptions to the World Trade Organization’s Most Favored Nation (MFN) principle, which provides that member countries ought not to discriminate between countries in the imposition of tariffs and other barriers to trade; they ought to treat all countries equally. At the same time, RTAs must not have the effect of raising the trade barriers applicable to third party countries to a level higher than they were before formation.
The WTO’s General Agreement on Tariffs and Trade 1994 provides that a customs union is
‘the substitution of a single customs territory for two or more customs territories, so that duties and other restrictive regulations of commerce […] are eliminated with respect to substantially all the trade between the constituent territories of the union, or at least all the trade in products originating in such territories, and […] substantially the same duties and other regulations of commerce are applied by each of the members of the union to the trade of territories not included in the union.’
Therefore, a customs union operates to eliminate tariffs between its members, while setting up a common external tariff (CET) applicable to non-members.
Customs unions generally apply to specified goods that are agreed upon by the members. With respect to these goods, once the common external tariff is paid at the initial port of entry, the goods may freely circulate within the customs union with low to no duty imposed. This does not mean that customs documentation is waived. In some instances, such as the EAC’s, the scope of goods that the customs union covers may be limited to those originating within the union’s member states. Therefore, traders would have to satisfy rules of origin to benefit from the tariff/duty waiver under the customs union. Custom unions typically cover goods but may be extended to cover services. The diagram below illustrates a customs union of which countries A and B are members:
With such integration, members of a customs union engage in negotiations as a single entity; any preferential arrangements (such as EPAs and FTAs) formed with third parties may risk compromising the integrity of the union since they may result in a variation in the common external tariff applied to the third parties. The EAC permits its members to enter into agreements with third parties provided that such agreements do not conflict with the EAC’s arrangement. Members concluding such agreements would have to notify the EAC, as discussed below.
FTAs, on the other hand, are agreements between two or more countries to remove tariffs and other restrictions on trade in goods and services that originate in those countries and are traded between them. They do not operate to establish a common external tariff. The General Agreement on Tariffs and Trade 1994 defines a free trade area (which is formed through an FTA) as a ‘group of two or more customs territories in which the duties and other restrictive regulations of commerce […] are eliminated on substantially all the trade between the constituent territories in products originating in such territories.’
Given that there is no common external tariff in an FTA arrangement, there is a risk that traders may opt to import their goods into an FTA member with a lower tariff rate than the rest, and then transport the goods to the other members with a view to benefiting from the duty waiver. To counter this, FTAs often contain rules of origin which require that the goods either wholly or substantially originate from a member state. With the application of these rules of origin, FTAs typically require that traders comply with more administrative processes to benefit from a tariff or duty waiver. Under an FTA, members may enter into negotiations in their individual capacities. Below is an illustration of an FTA arrangement between countries X and Y:
EPAs are development-oriented FTAs that are negotiated with the goal of promoting trade liberalization between the state parties on a reciprocal basis. A key feature of EPAs is the developmental objective which is achieved through asymmetry in the liberalisation of trade between state parties. For instance, the Kenya-UK EPA provides for a tariff regime that requires the UK to immediately abolish customs duties on products originating in Kenya while Kenya is required to progressively abolish customs duties on products originating in the UK, on a staggered basis.[i]
Generally, EPAs are viewed as vehicles for achieving developmental goals that go beyond promoting trade and investment. Their origin can be traced to the EPAs signed between the European Union and African, Caribbean, and Pacific Countries (ACP). These agreements were negotiated under the auspices of the Cotonou Partnerships Agreement, 2000. The agreement was an extension of the Lome Convention which provided for preferential tariff arrangements for Sub-Saharan African countries accessing the EU markets between 1990 and 2000.
On 9 March 2021, the Kenyan Parliament ratified the Kenya-UK EPA which seeks to ease long-term trade between the two countries for a 25-year duration. The negotiation and subsequent ratification drew criticism due to the apparent exclusion of other EAC Partner States, and bilateralised negotiation with a third-party country. Some critics went as far as to label Kenya as an economic regional hegemon in Eastern Africa. However, there are two fundamental reasons for the bilateral negotiations.
First, the expiry of the Cotonou Partnerships Agreement in 2020 created concern over the continuation of preferential market access for Kenyan exports into the EU and the UK. The need for an EPA was arguably more pressing for Kenya than the other EAC Partner States, primarily because all other EAC members are classified as Least Developed Countries (LDCs), while Kenya is classified as a Lower Middle-Income Country.[ii] Therefore, once the Cotonou Partnership Agreement lapsed, the LDCs could still continue to enjoy the quota-free access and nil rates of import duty on goods other than arms and ammunition in accordance with the UK Generalised Scheme of Preferences for LDCs. In contrast, the trade relations between Kenya and the UK would revert to the WTO Most Favored Nation regime which is less favourable.
Second, it could be argued that past experience plays a role in Kenya’s hesitance to pause the negotiations until the EAC partner states take a common position. In fact, while the EU and EAC finalised the negotiations for an EPA on 16 October 2014, Kenya and Rwanda, who signed the EPA in September 2016, remain the only EAC signatories to date.
The EAC and the Kenya-UK EPA have different tariff regimes. Article 12 (1) of the EAC Customs Union Protocol (the Protocol) establishes a three-band Common External Tariff (CET). The CET imposes a minimum rate of 0%, a middle rate of 10% and a maximum rate of 25% in respect of all products imported into the EAC. When the CET came into force in 2005 the partner states agreed to place the maximum rate of 25% on a list of sensitive goods so as to protect domestic production and development of infant industries within the EAC Community.
The tariff regime under the Kenya-UK EPA is asymmetrical. Customs duties on products originating in EAC Partner States, in this case Kenya, shall be entirely eliminated on all products, with the exception of arms and ammunitions as stated in Annex I (1). Conversely, the customs duties on products originating in the UK and imported into Kenya are subjected to a progressive system of elimination as per Annex II. These duties shall be entirely abolished 25 years after the entry into force of the EPA. Notably, Annex II(d) similarly provides for a list of sensitive goods which are excluded from the tariff phase down regime. This list is populated with primary agricultural commodities such as potatoes, avocadoes, pineapples, natural honey as well as processed goods such as mineral water and whiskies. The tariffs on these products shall be retained.
The divergence in tariff regimes is best illustrated by the application of different tariffs to similar products. The EAC CET 2017 imposes a duty of 25% on all fish, crustaceans, molluscs, and other aquatic invertebrates as per Schedule 2, Chapter 3. This list includes freshwater fish, yellowfin tuna, and tilapia, among others. Conversely, the EPA provides for a tariff phase down regime for these aquaculture products which are all captured in Annex II (C). The tariffs on products in Annex II (C) are presently at 25% but will be reduced over the next 25 years to 0%. Therefore, after 25 years of the parallel operation of the EAC CET and the EPA tariff regime, the EAC CET will still impose an import duty of 25% on imported tilapia while the imported tilapia from the UK into Kenya will not attract any import duty as per the EPA.
The divergence in tariff regimes appears to present a challenge to Kenya fulfilling its obligations under two different trade agreements. However, the EAC Council may permit the stay of application of the CET duty rates. This was the case with Uganda which was permitted to increase and decrease certain import duties for a period of one year from 1 July 2020 to 1 July 2021. During this period, Uganda increased the import duty of processed tea and processed coffee from 25% to 60%. However, with the recent push to finalise the CET by the end of the year, this appears unlikely.
Furthermore, Article 37 of the Protocol permits partner states to enter into bilateral trade agreements with third party countries. Article 37 of the Protocol covers ‘Trade Arrangements with Countries and Organizations Outside the Customs Union.’ It provides the process that an EAC partner state must follow when concluding or amending a trade agreement with a foreign country. The partner state is obligated to notify the EAC Secretary-General of the terms of the agreement once it “intends to conclude or amend an agreement”. The Secretary-General then presents the agreement to other partner states for their comments and proposals. If comments and proposals are received, then the Secretary-General is required to convene a meeting of the Council to consider these submissions. If none are received, then the partner state in question may proceed to conclude the agreement. If none of the partner states review the proposals and make their submissions, there is nothing stopping a partner state from concluding and operationalising an agreement that is inconsistent with the Protocol, aside from perhaps a referral of the matter to the East African Court of Justice, and more broadly, political goodwill.
As the Kenya-UK EPA has now come into force, it is likely that there will be discourse around its conformity with the EAC Customs Union, particularly due to practical implementation challenges that may be faced.
It is still too early to tell exactly how the Kenya-UK EPA will operate in relation to the EAC Customs Union. As the EAC continues to integrate, and countries such as Kenya continue to pursue bilateral trade agreements, there are likely to be operational incompatibilities. In the next part of this series, we discuss the likely operation of a potential US-Kenya FTA.
This article was authored by: